Austerity Isn't Working. Time for Plan B.

Ever since the financial crisis of 2008 it feels as if markets are never that far away from another bad news story.
Riot policemen push back demonstrators as they try to approach the finance ministry in Athens.

Take the last month for instance. Japan fell back into recession as did Australia. Greece looks like it will need a second bailout or a “re-profiling” or restructuring of its debt – with both terms sounding suspiciously like the other.

The Portuguese Socialists lost the election, the Spanish government suffered losses in local elections because of drastic spending cuts aimed at keeping it from going to the IMF for help. So did the German government despite the German economy being by far and away the healthiest of the European economies.

The Organisation for Economic Cooperation and Development (OECD) lowered its gross domestic product growth forecast for the United Kingdom, while Moody’s rating agency put 14 British banks on warning that they faced a downgrade in their credit ratings.

The United States was warned of a negative outlook on its economy and possible downgrade of its credit rating by Standard & Poor’s and failed to reach agreement over raising the Federal debt ceiling having barely managed to reach agreement over the Federal budget.

And yet - despite the threat of bankruptcy in August if no agreement is reached with Congress - 10-year US bond yields fell to historic lows as investors sought safety from the volatility elsewhere.

While the US has pursued a policy of easy money and low interest rates, much of Europe has over the last twelve months adopted fiscal austerity measures, cutting public spending in an effort to deal with deficits and in order to convince the bond markets their economies are on a stable footing.

Mixed Results

However, such austerity measures have had mixed results.

In Germany three quarters of negative growth in 2008 during the financial crisis have been followed by positive growth ever since, with GDP in the first quarter of 2011 standing at 1.5 percent. This has been in spite of spending cuts of 80 billion euros ($116.8 billion) introduced in June 2010 by which time the German economy had seen four quarters of positive growth already.

In Portugal, the reverse has been true. In November 2010 Portugal voted through an austerity package that aimed to cut the budget deficit from 9.3 percent to 7.3 percent by the end of the year and to reduce it to 4.6 percent by the end of 2011.

But GDP in Portugal fell by 0.7 percent in the first quarter of 2011, having fallen by 0.3 percent the previous quarter, after recovering at the start of 2010 - before austerity measures were introduced - from the previous year’s recession in which the economy declined by 1.7 percent overall.

Meanwhile, in the UK, having appeared to have dug its way out of the worst recession the country had experience since the Great Depression - and a total decline in GDP of 9 percent between the third quarter of 2007 and the second quarter of 2009 according to the Office of National Statistics - growth appeared to stall at the end of 2010.

The economy shrank by 0.5 percent in the final quarter of the year only to recover 0.5 percent in the first quarter of 2011 effectively meaning it stood still and there have been growing calls for policy makers to consider a plan B even though the government’s spending cuts have yet to fully take hold.